Get the Customer Behavior You Want

The 2008 book "Nudge," coauthored by the scholars Cass Sunstein and Richard Thaler, made a splash by applying insights from behavioral economics to the realm of personal finance.

The main idea is that if individuals are given the right incentives, they'll make smarter choices with their money. One frequently cited example involves 401(k) enrollment. Lots of people never sign up for a retirement savings plan, even though it's in their own interest to do so. "Nudge" proposed a simple tweak — offer 401(k)s on an opt-out basis, rather than opt-in — in order to boost enrollment.

That change makes sense. But there are millions of Americans, mostly on the lower end of the income scale, who aren't eligible for a 401(k), and don't even have the cash they need to get to their next payday.

Today, a new round of experimentation — call it Nudge 2.0 — is applying findings from behavioral economics to the financial lives of poor Americans.

Spring Bank in New York City launched its Borrow-and-Save loan in September. The product requires borrowers to put 25% of the loan amount into a savings account that can only be accessed at the end of the loan term. A customer who borrows $500 to pay an emergency bill would receive $375; the other $125 would be set aside as savings, and later could be used to pay for the next surprise expense.

Although payday lending is illegal in New York, Spring Bank officials say their product offers a better alternative to pawn shops and rent-to-own stores. A $500, six-month loan carries an annual percentage rate of 18%. "If we come out with a sustainable, responsible product, we're going to cut the legs out from under some other products," says Brian Blake, vice president at Spring Bank.

Related innovation is also happening in the credit card industry. FS Card, a Washington, D.C.-based firm started by several former executives at Capital One Financial, recently announced plans for a subprime credit card that will offer incentives and rewards when customers habitually make on time payments in excess of the minimum amount due. So customers will still be borrowing, but they'll be accumulating rewards for borrowing less than they're allowed to.

Though tight-lipped about the product's specific features. Marla Blow, FS Card's CEO, notes that when customers perennially hover near the credit limit, it's actually disadvantageous to them, because then they can't use that card very often.

It used to be that subprime card issuers relied on hefty fees for late payments and exceeding one's credit limit. But in a post-crisis environment where those fees are tightly restricted, there may be a closer alignment between the interests of the card issuers and those of their low-credit-score customers.

Another application of behavioral economics to the financial lives of poor people involves the use of raffles or lotteries to incentivize savings. The notion of harnessing people's urge to gamble to a more productive end, known as prize-linked savings, is employed in more than 20 countries. And there's evidence suggesting that it works; a paper published in October by University of Maryland economists found what its authors called "strong evidence" that prize-linked savings leads participants to set aside more cash than traditional savings accounts.

Until quite recently, prize-linked savings accounts were illegal in most states, but the wind seems to be blowing in favor of looser rules. Several states have changed their laws in recent years, and in December, President Obama signed a law that allows banks to create such accounts.